Question

Supposed you observe the following exchange rates MXP8/$, RMB7/$, AND MXP 1.3/RMB. What is the cross rate between RMB and MXP? If you invest $100, how much is your triangular arbitrage profit? Show work please.

Answer 1

Cross rate between RMB and MXP =
		MXP/$	=	$8	=	1.14
		RMB/$		$7
It means per RMB = 1.14 MXP
Actual Exchange rate between RMB and MXP = 1.3 MXP per RMB
Identifying an arbitrage opportunity
We have $100 and if we purchase MXP directly with a quote MXP8/$ then we will get only MXP800.
But if we first purchase RMB from $100 then convert it into MXP we will get MXP910 :
=	100*7*1.3		910
As MXP is cheaper in direct quote between RMB and MXP .i.e. 1.3 MXP per RMB
Now convert back the MXP into $ by using the direct quote between MXP8/$
=	910		=		$ 113.75
	8
Calculation of profit
Initial Investment		$100.00
Realized value		$ 113.75
Profit =		$ 113.75-$ 100		$   13.75